It shapes every big company in America, even those it never directly touches.
On the latest episode of The Weeds podcast, I sat down with Emily Stewart, a business and politics reporter, to talk about the private equity industry — one of the most powerful and least understood influences on the contemporary American economy.
Emily has written at length about private equity’s role in recent bankruptcies of major retailers and about Elizabeth Warren’s plan to reform and re-regulate the industry. Those are great long reads if you want to go deep, and, of course, the episode itself is chock-full of details.
But here are seven main takeaways:
- The private equity business model doesn’t have a technical or legal definition, but it normally refers to leveraged buyouts — a private equity firm offers to buy a business with cash that’s mostly borrowed and the debt that accrues to the books of the acquired company rather than the private equity firm itself.
- Because companies bought through the LBO process are now indebted, the business inherently becomes riskier and more fragile than it was before the acquisition — a small downturn might make them unable to cover interest costs and force them into bankruptcy.
- At its best, private equity provides a new infusion of energy, money, and outside expertise that can help improve a company’s operational performance and set the stage for expansion.
- At other times, the debt burden induced by the LBO simply makes it harder to raise capital for needed investments, making it even more difficult for the acquired company to survive and thrive in a changing business environment.
- Sometimes, a private equity deal ends up profitable because the company is turned around and then resold as a success story at an initial public offering. But even an investment that ends in bankruptcy can be profitable because the private equity firm extracts funds via management fees and special dividends.
- Only accredited investors (basically rich people and large institutions) can invest in private equity funds, which allows them (like hedge funds and other exotic investment vehicles) to operate in a very lightly regulated environment.
- The existence of a large private equity industry influences the entire business world. Any company whose managers don’t adhere to the philosophy of maximizing shareholder value over any other interest (a sense of ethics, an obligation to long-time workers, a commitment to a particular community) risks being targeted for a leverage buy-out that would restructure the company to maximize shareholder value. Therefore any company that wants to stay independent more or less must play by shareholder value rules — the private equity industry serves as the enforcement arm of a larger philosophy.
Listen to the whole thing!